Not so fast big boy: Small RIAs will survive M&A trend

There is no question that the planning profession is currently experiencing a period of consolidation.

Smaller firms are merging to create multi-partner entities, more often than ever before. Larger firms are buying practices that never created a viable succession strategy. At every conference I attend these days, I hear hallway conversations about the advantages of scale.

Last time I checked, the giant brokerage retail operations were dying off like the dinosaurs of an earlier era, says columnist Bob Veres.

This has created an interesting crisis of confidence among planning professionals who have not climbed onto the growth train, and feel they’re being left behind. The angst is exacerbated by pundits and columnists who project out this consolidation trend in linear fashion, painting a bleak picture of the profession’s future.

Mark Hurley, founder and CEO of the Dallas-based Fiduciary Network, wrote an influential series of white papers suggesting the planning world would evolve the same way the institutional pension fund consultants did: Once the firms were plentiful, they consolidated to a handful of much larger firms, and finally only a few giants were left standing.

THE NEED FOR SCALE?

Edelman Financial Services CEO Ric Edelman’s monthly column has communicated the same story: If you don’t have scale, and a lot of it, there is little chance you’ll survive against the big boys.

I’ve never believed this nonsense. Didn't the planning profession start out by competing directly with the large brokerage firms, each of which was bigger than the entire new profession scurrying among their feet?

Last time I checked, the giant brokerage retail operations were dying off like the dinosaurs of an earlier era (think Bear Stearns, Lehman Brothers, E.F. Hutton, Prudential Securities, Shearson, Drexel Burnham Lambert, Salomon Brothers, Dean Witter Reynolds and Kidder Peabody), while planning firms have become more numerous and prosperous.

If small firms were doomed to fail whenever they have to compete against larger ones, the profession would never have existed to begin with.

PICTURING THE FUTURE

But that merely suggests what won’t happen as a result of the recent urge to merge. Is there any way we can get a peek at what the future will look like?

While I was researching my new book about the planning profession, I found myself looking at other professions, and wondering how they managed to evolve through their first generation of solo founders into a broader mix of large and small competitors.

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If small firms were doomed to fail whenever they have to compete against larger ones, the profession would never have existed to begin with.

The results are interesting. Let’s start with law firms. The American Bar Association provides statistics on the sizes of law firms in the U.S. from 1980 to 2005, and here’s the surprise: A consistent 49% of all law firms have been solo.

Solo firms have not been scaled out of business; they’ve consistently represented nearly a majority of the profession. Meanwhile, the percentage of firms ranging from two to 20 lawyers has dropped from 38% in 1980 to a still-healthy 26% in 2005. Another 6% of firms have 21 to 50 lawyers, and 4% employ 51 to 100.

In other words, well over half of all legal firms are relatively tiny, and this has been true for quite some time. Meanwhile, the profession has regional firms and law firms that enjoy a sizable presence in just one city.

At the top end, we find a handful of truly national firms, led by Baker & Mckenzie (4,363 attorneys), DLA Piper (3,756), Norton Rose Fulbright (3,371), Jones Day (2,562) and Hogan Lovells (2,516). I suspect that, when you look behind the statistics, you’ll find a vibrant ecology where the larger firms take on many young associates who compete with each other to become partners.

THE LARGE AND SMALL CYCLE

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I think these other professions offer clues about how the current consolidation trend will play out in the planning profession.

Eventually, many of those associates will leave to start their own firms, replenishing the number of solo practices as the more established solos merge, acquire or grow larger in order to get more scale. Those new firms, which become significant presences in a city or region, will then take on associates hoping to become partners, some of whom will eventually refresh the solo marketplace all over again.

How about a more closely related profession: accounting firms? According to statistics on the American Institute of Certified Public Accountants website, 68.5% of all accountants currently work at a firm with 0 to 4 employees. Another 18.9% of accountants are employed at small firms with 5 to 9 employees. Firms with 10 to 19 employees have another 8.1% of the total, meaning that 95.5% of accounting professionals work at firms with 19 or fewer employees.

Once again, small is beautiful for a significant number of professionals, and scale is not destiny.

At the top end, of course, you have large national firms Deloitte (203,000 employees), Price Waterhouse Coopers (184,000), Ernst & Young (175,000) and KPMG (155,000). But if you go back as far as I do, you see attrition in these upper ranks.

I recall when we talked about the Big 8 firms; now the national firms are described as the Final 4. If scale were destiny, the number of big firms would be growing, not shrinking.

I think these other professions offer clues about how the current consolidation trend will play out in the planning profession. The growing number of mergers, acquisitions and multiple succession partners will eventually lead to the creation of a small number of truly national firms, which will each employ thousands of planners.

Other ambitious firms will become large regional presences, and there will be firms of significant size in each of the 382 major U.S. metropolitan areas.

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The bottom line here is that, if you’re happily solo, or if you’re feeling left behind because you haven’t taken on a few partners, don’t think the bus has left the station.

SOLO SHOPS WILL SURVIVE

But at the same time, if the other professions are any indication, most of the future financial planning marketplace will consist of solo shops and very small practices, and that number will stay consistent even as those firms merge and evolve, because would-be partners at the larger firms will be constantly replenishing the small-practice rolls.

Those smaller firms will do a great job of servicing the many clients who want to face-to-face service from the person whose name is on the door, while the giants will face constant challenges to their supremacy.

The bottom line here is that, if you’re happily solo, if you aren’t trying to move up on the Largest Wealth Management Firms lists, or if you’re feeling left behind because you haven’t taken on a few partners, don’t think the bus has left the station.

Not only can you be viable without enormous scale, but it’s highly likely that you’ll still be in the majority, as the current consolidation trend finally plays itself out decades into the future.

Scale is nice, but it has never been a condition for survival, prosperity or great client service. If you don’t believe this, just ask a former Lehman broker.